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What the Bank of America got wrong in Valuing Bitcoin

Oh where to start…
The Bank of America Merrill Lynch report, which attempted to calculate a “fair market value” for bitcoin, was as ground breaking as it was flawed. Ground breaking in the sense it is the first report by a major financial institution confirming that bitcoin has value, and flawed in almost every way it attempted to calculate this “fair” value.

To start the report was based on assessing bitcoins value in two parts, first as a store of value, second as a means of exchange. Let’s focus on the means of exchange first.

The BofA Merrill Lynch report makes a few (frankly retarded) assumptions. Firstly that bitcoin is exclusively useful in e-commerce transactions and remittances, and secondly that bitcoin will only be used for e-commerce transactions in the US.

Although bitcoin has extremely strong potential in e-commerce and remittances, bitcoin is arguably simpler and easier that existing in-person transaction facilities such as credit /debit cards or even cash (don’t we all hate carrying spare change).

In terms of establishing a fair market value based on bitcoin as a means of exchange, really we should be looking at all areas of global commerce, not just the US and not just online.

In terms of online and offline acceptance, preliminary research shows that less than 0.01% of businesses (less than one in 10,000) are currently accepting payment in bitcoin which suggests immediate 1,000,000% growth potential. But for the sake of conservatism let’s consider a situation where just 1% of businesses accept bitcoin. Further, and also for the sake of conservatism, let’s consider only global merchandise sales of $17.8 Trillion.

Just 1% of global merchandise sales would see $178 billion in bitcoin transactions.

At this point we can point out a critical flaw of the BofA Merrill Lynch report which was to ignore the fact that bitcoin is not just a transactional technology, but also a currency in its own right. As such we need to look at reasonable money supplies and money velocity. A fair money velocity of 5 (each BTC is turned over 5 times per year, conservative when compared to traditional currencies) would require a bitcoin market cap of $35 billion to facilitate this 1% of global merchandise transactions.

The BofA estimates are already look a little on the low side.

In truth what we should really consider is the possibility that bitcoin will take a noticeable chunk out of total global commerce. We can estimate the money supply required to facilitate 1% of global commerce simply by considering the total global M2 money supply, which is approximately $66 Trillion. Just 1% of total global commerce therefore requires bitcoin to have a market cap of $660 billion.

Remember we still haven’t considered the “store of value” potential, nor another important factor, lost coins.

To consider bitcoins potential as a store of value we need to consider not just silver (a precious metal picked out of thin air by the BofA report without any decent justification) but also Gold. I would also argue we should hedge funds in this calculation.

If we assume bitcoin can provide a store of value to the combined Gold, Silver and Hedge Funds markets, then we are looking at another $4.5 trillion of markets, 1% of which is $45 billion.

The BofA report suggests the volatility of bitcoin presents a diminution in value, but I’m not so sure.

Consider the case of a publicly listed stock, for example AAPL (apple), which trades at a P/E of 14+. Although bitcoin is not a stock but arguably an EFT on it’s own ecosystem, there is a value associated with projected appreciation. There is an extremely strong case for projecting continued appreciation in the value of bitcoin for the foreseeable future, and as such there must be some value in the opportunity cost of including bitcoin as an investment.

Although bitcoin appears to be extremely volatile, it is also vastly more fungible than Gold. The world at large expects bitcoin to magically be worth “something”, without ever going through the steps required to get from nothing to this “something”. I personally think bitcoin is having to cram 10,000 years of history into it’s 21st century equivalent of just a few years. The BofA report assumes bitcoins volatility will persist, however this is unlikely to be the case, especially if a “fair market value” of $15 billion can be established. If it turns out we can come up with a fair market value the value of each bitcoin will naturally stabilise around the forecast level. The paradox being if this were the case, the value of each bitcoin as per the BofA report increases and the total “fair” market cap would become $35 billion.

But crucially bitcoin is a new paradigm and impossible to value with traditional methods, the markets just have to decide. Never before have we had a currency that is itself, an ETF of, itself.

Never before have we had an uncontrollable global currency which is deflationary in nature, which is trading with and against all existing inflationary currencies, concurrently. Compound this with its “ETF of itself” nature and we can only conclude that…

Bitcoin is an economic black hole.

Given a choice, any sane human will prefer a deflating currency as opposed to an inflating currency, regardless of the economic problems associated with deflation. Its adoption drives its deflation in a self-actualizing loop until all value to be found in the inflating currencies is sucked into bitcoin. Although inflationary currencies inflate beyond use, traditional stores of values survive, as do businesses that adapt to the inflation & bitcoin.

So there is one more point where all current “market cap” valuations are wrong, and that is the problem of an unknown quantity of lost coins. It is estimated that approximately 30% of all bitcoins currently in existence are lost and unrecoverable. In one case 7500 bitcoins were thrown into the bin, and in many other cases passwords have been lost, and bitcoins of very early adopters have just been forgotten/erased. These lost and unrecoverable bitcoins are forever removed from the bitcoin economy and therefore do not contribute to a “market cap” – therefore if a fair market cap is (as the BofA report suggests) around the $15 billion mark, then each bitcoin should have a potential worth of $1950, not $1300.

In truth the world has never seen anything like bitcoin before and attempting to value it with traditional methods is doomed to always fail. As an economic black hole bitcoin has far reaching potential and could impact human transaction on a scale never before witnessed. Although some have suggested each bitcoin could be worth “$100,000 to $1million each” the reality could very well be in this region.

So I leave you with a final thought – if bitcoin could match the value of 1% of all current global assests, ignoring its potential as a means of transaction, one bitcoin would be worth in excess of $100,000.